The Economist: Are Americans getting poorer or wealthier?

By Tucker Hart Adams

Published: 2011.06.01 09:01 AM

The concepts of wealth and income are frequently confused, and the two words used interchangeably. In fact they are quite different.

Income is a flow - in other words it has a time dimension. Wealth is a stock, a snapshot at an instant in time. Income can add to or subtract from wealth, depending on whether we save (spend less than we earn after taxes) or go into debt. Wealth, in turn, can add to income when it produces a stream of interest or dividends.

Economists at the Federal Reserve, who conduct periodic surveys of household wealth, recently released a study of what happened to wealth and income between 2001 and 2004. After subtracting out inflation, the real net worth of the median family (the level at which half of all families were richer and half were poorer) rose 1.5 percent to $98,100. This was well below the 10 percent increase from 1995-1998 or the 17 percent gain from 1998-2001, but better than the 9.9 percent decline from 1989-1992.

What is going on here? Why did the growth in wealth slow so substantially?

The 1990s encompassed a phenomenal bull market in stocks. A dollar invested in the stock market in 1994 was worth more than $3 by 2000 after adjustment for inflation. With almost 52 percent of American families owning stocks at the end of that boom, it's no wonder that net worth soared. Real estate, including owner-occupied homes, also surged in value. One didn't have to add anything out of income to one's assets to see them rise rapidly. That came to an end with the bursting of the technology bubble. By 2002, the stock market dollar that had grown to $3 had shrunk to only $1.50 in real terms. The decline in the stock market wiped out $7 trillion of paper wealth.

A declining saving rate compounded the problem. Consumers, who had found it unnecessary to save out of income for almost a decade, continued to spend, going into debt and extracting equity from their homes in order to maintain spending. Mortgage debt rose 27 percent, and the share of families with mortgages increased three percentage points to 48 percent. This increase in debt and the spending of home equity had a negative effect on wealth. Only the continued increase in home values - up 28.1 percent - kept net asset growth in positive territory.

The impact of the slow increase in median family wealth wasn't spread evenly across all American families. The wealthy fared better than the poor. The wealthiest 10 percent of families saw their median net worth rise by 4 percent to an average of $924,100. The poorest 20 percent, in contrast, saw their median net worth fall 13.4 percent to $34,300. The poorest 10 percent owed more than they held in assets.

This immediately became a political issue. The Administration in Washington announced that the situation was actually much better than the Fed report suggested: Per capita net worth rose 24 percent from early 2001 to the end of 2005 and per capita income was up 8.2 percent from January 2001 to January 2005.

The two sets of data, however, are not comparable. The Fed study looks at changes after removing inflation; the Administration data leave inflation in. Average income and wealth are distorted by what happens to the very poor and the very wealthy. Median data are more representative of what happens to the middle class, which is how most Americans identify themselves.

What can we conclude from all of this? First, there are many ways to measure wealth, and it is important to compare apples to apples. Second, a few very rich families have a huge impact on averages; median data are more representative of what is happening to the middle class.

Third, there is a cyclical component to the varying rates of growth in wealth, but it is too soon to know if there is also a secular component. How quickly consumers move from the negative saving rate of 2005 to something closer to the 10 percent saving rate of a few decades ago will determine the timing and severity of the next recession. {pagebreak:Page 1}

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